Denmark's central bank is reaching for bigger bazookas to battle the speculators betting it will be forced to abandon its currency's peg to the euro.
"They've thrown the proverbial policy toolkit at defending the euro-Danish peg," Kamal Sharma, a foreign currency strategist at Bank of America Merrill Lynch, told CNBC Thursday. "They will continue to intervene with the possibility of further rate cuts, even the tail risk of the recalibration of the trading range."
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Bets that the krone will rise are building. Some of the flows have headed for Denmark's stock market, with Danish-focused mutual funds and exchange-traded fund (ETFs) seeing $230 million in inflows over the past six weeks, according to data from Jefferies.
Slings and arrows
Barclays analysts called it "the slings and arrows of market speculation."
It bears similarities to the speculative attacks that led Thailand to abandon the baht's peg to the dollar in the late 1990s -- the "Lehman-moment" of the Asian Financial Crisis. Denmark's peg is set for the krone to trade within a 2.25 percent band of 7.46038 to the euro, although it has been holding it in a 0.5 percent band. Although the has recovered somewhat this week, it has fallen around 17 percent against the greenback since the beginning of 2014.
There are clear differences with the attack on the baht. Thailand, faced with massive speculative bets that the baht would fall, nearly depleted its foreign exchange reserves trying to support its currency. AAA-rated Denmark, however, is trying to weaken, not strengthen, the krone, meaning it will be printing money and amassing foreign reserves.
Of course, just because there's a speculative attack on a currency doesn't mean it will succeed.
Denmark's policy makers certainly aren't rolling over for the market.
"We have an unlimited supply of our own currency, the kroner. And we are going to do whatever it takes to defend the peg," Lars Rohde, Denmark's central bank governor, told CNBC.
His comment echoes a seminal moment in the euro zone crisis, when European Central Bank (ECB) President Mario Draghi said in 2012 that the bank stood ready to do "whatever it takes" to preserve the European monetary union, a declaration that drew a line under the region's credit crisis and bolstered market sentiment.
On Thursday, Denmark's central bank cut its benchmark interest rate deeper into negative territory -- to negative 0.75 percent, matching the Swiss National Bank (SNB). It's the Nationalbanken's fourth interest rate cut in a bit less than a month. That followed Copenhagen's unusual step of canceling the country's bond sales for the year to stem further inflows; the country's financing needs for 2015 have already been met.
Rohde was very clear on the message he wants to send to the market: "Stay away," he said. "We simply will make it unattractive to invest in Danish kroner-denominated assets." The yield on Denmark's 10-year government bond is trading at a yield of around 0.24 percent, the second-lowest in the world after Switzerland's negative 0.10 percent.
"The reason why Switzerland and Denmark are both behaving aggressively against the euro is because traders in Europe are putting a lot of pressure on it, arguably to test policy makers' resolve to come to a resolution on Greece and some of the fault lines in Europe around risk-sharing," Rebecca Harding, CEO at Delta Economics, said via email Thursday, before the Nationalbanken's latest rate cut.
"Defending the peg is an expensive policy and the Danish Central Bank has had to build up considerable reserves to do this," she said. "The key question is whether or not, even by suspending sales of government debt, it can afford to continue to do this. The jury is out on that."
In January, Denmark's foreign-exchange reserves climbed to a record high 564.1 billion kroner after foreign-exchange intervention of more than 106 billion kroner in the month. That compares with a 40 billion kroner increase in reserves in November 2008 during the Global Financial Crisis and a 20 billion kroner rise during the worst of the 2012 Greek crisis, Bofa's Sharma said in a note Tuesday, calling the latest increase "staggering."
Building large stocks of foreign currency reserves can have negative implications for Denmark's economy. While the usual feared result of printing money -- inflation -- has become rare, bank lending can get crowded out if the central bank needs to raise reserve requirements to "sterilize" their actions.
It's concerns like these that spurred the Swiss National Bank (SNB) In January to abandon its more than three-year-old policy of pegging its currency to the euro to prevent from strengthening too much and causing deflation. Analysts have noted however, that while Switzerland's reserves had swelled to around 80 percent of its gross domestic product (GDP), Denmark's reserves are only around 30 percent of GDP.
Denmark to hold its ground
But despite the hedge fund bets, many analysts believe Denmark's peg will stick.
"The threshold for the abandonment of the peg is exceptionally high," BofA's Sharma said, noting the peg has been in place for at least 30 years. Before its peg to the euro, the krone was pegged to Germany's mark. "It's a perfectly credible policy. It's a necessary step for them for eventual membership in the monetary union [with the euro]."
Additionally, more than 60 percent of Denmark's trade is with the euro zone.
Some expect Nationalbanken will bring out even bigger guns to protect the peg.
"With upward pressure on the currency unlikely to abate as the European Central Bank commences quantitative easing (QE), we think that the Nationalbank will need to do even more," Jessica Hinds, European economist at Capital Economics, said in a note Thursday. "Given the ineffectiveness of the measures taken so far, Danish QE is looking increasingly likely."
"Suspending the sale of government bonds is what you would call Danish way of doing QE," Nationalbank Gov. Rohde told CNBC. "In some countries, you have the government issuing bonds and then the central banks are buying the very same bonds. In Denmark, we simply stopped the issue of government bonds."
—By CNBC.Com's Leslie Shaffer; Follow her on Twitter